by Tyler Durden
Ever since the launch of Japan’s QE, and worsening in the aftermath of January’s shocking NIRP announcement, Japan’s bond market, which moments ago slid to new record lows yields across the curve, has had its share of near-death experiences: between repeated VaR shocks, to days in which not a single bond was traded, to trillions in bonds with negative yields, it has seemed that the Japanese Government Bond is on life support. That support may be ending.
According to Nikkei, and confirmed by Bloomberg, Japan’s biggest bank, Bank of Tokyo-Mitsubishi UFJ, is preparing to quit its role as a primary dealer of Japanese government bonds as negative interest rates turn the instruments into larger risks, a fallout from massive monetary easing measures by the Bank of Japan. While the role of a Primary Dealer comes with solid perks such as meetings with the Finance Ministry over bond issuance and generally being privy to inside information and effectively free money under POMO, dealers also are required to bid on at least 4% of a planned JGB issuance, which as the Nikkei reports has become an increasingly heavy burden for BTMU.
In other words, one of the key links that provides liquidity and lubricates the Japanese government bond market has just decided to exit the market due to, among other thinks, lack of liquidity entirely due to the policy failure of Abenomics in general, and Kuroda’s disastrous monetary policies in particular. One could, of course, ask just how does BTMU plan on also exiting the Japanese economy itself, if and when the country’s $8 trillion bond market implodes, but we doubt the bank will ever be able to answer that.
The ministry is expected to let the bank resign.
Japan has 22 primary dealers including megabanks and major brokerages. Several foreign brokerages had pulled out before as part of restructuring efforts at home or for other reasons, but BTMU will be the first Japanese institution to quit.
In a revolutionary shift, one created by the Bank of Japan itself, banks, once the biggest buyers of JGBs, see little appeal in sovereign debt today. The bonds have very low yields, and a rise in interest rates could leave banks with vast unrealized losses. Private-sector banks held just over 229 trillion yen ($2.13 trillion) in JGBs at the end of 2015, nearly 30% less than at the end of March 2013, before the BOJ launched massive quantitative and qualitative easing measures.
Negative rates introduced this year by the BOJ reinforced the trend. The highest bid yield on benchmark 10-year JGBs sank to a record low of negative 0.092% on Thursday. BTMU was the fifth-largest buyer of Japanese government bonds among the 22 primary dealers until spring 2015, but ranked 10th or lower between October 2015 and March 2016 as shareholders turned up their nose on government debt.
Ironically, the same NIRP that was supposed to save Japan’s economy is now set to kill Japan’s bond market: Japan’s three megabanks halved their JGB holdings to a total of 54 trillion yen in the three years through March. They get little benefit from building up their positions on negative-yield bonds, which result in a loss when held to maturity.
Meanwhile, Peter Pan Kuroda and his merry monetary lunatics, continue continue to crowd out the entire market, purchasing 100% of gross issuance, or a whopping 80 trillion yen in JGBs annually, and last year its holdings surpassed that of commercial banks in 2015 for the first time in about 40 years.
For now, Japan’s increasingly fragile bond market appears stable thanks to the central bank’s massive intervention, however the irony is that the more the BOJ intervenes the more it will have to intervene to sustain the illusion that there even is a bond market. That will not last long, and now that the Primary Dealer exodus has begun, what little liquidity there was in JGBs will evaporate completely.
For now, few expect immediate turmoil from BTMU ceasing to be a primary dealer. But a drop in private-sector interest could undercut the market in the medium to long term. Actually replace “could” with “will.”
Analysts, while slow to pick up on the news, are waking up to a changed world for the world’s second largest government bond market. According to Chotaro Morita, chief rates strategist at SMBC Nikko Securities, news that Japan’s largest banks may return its primary-dealer license signals a “seismic change” in Japan’s govt bond market, initially triggered by BOJ’s QQE.
Trying to downplay the impact of this shocking move, Morita said that the short-term impact on JGB market may be limited given BOJ’s purchases, however he adds that “if other large banks follow this move, it’s hard to say there will be no impact.”
According to the Nikkei that’s precisely what is about to happen: Sumitomo Mitsui Financial Group and Mizuho Financial Group also may consider quitting like BTMU.
As a reminder, according to the BIS, Japan had a little over $8 trillion in government debt as of 2015.